The year ahead: an economic perspective

Even an end to loose monetary policy is unlikely to derail global growth in 2018 says BNY Mellon’s Market Strategy Group.

As we look forward to 2018 we think it’s fair to say the global economy is enjoying a sustainable economic expansion with a long-awaited cyclical recovery in investment, manufacturing, domestic demand, and trade. For the first time in a decade, major developed and emerging economies are in sync, enjoying cyclical growth upswings.

This represents the success of worldwide extraordinary monetary policy in boosting growth. Expectations of more robust global demand, Asia, and subsequent optimistic financial markets are all positive occurrences.1 The IMF projects global growth to rise from 3.6% in 2017 to 3.7% in 2018. As the effects of the financial crisis finally fade across economies, expectations are for growth to accelerate in many countries over the next 12-18 months.

Developed markets

The US recovery has been quite shallow compared to previous upturns, so much so that nominal GDP, based on Q3 2017, would be 7.7% higher or US$20.8 trillion if growth was in line with the historical median at this point of the cycle. Recent trends in the data point to an improving economy as evidenced by stronger than expected consecutive quarters of 3%+ GDP growth. Expectations for the US are for a near- and medium-term boost to activity and investment should Congress approve a tax overhaul, which could then extend the recovery. Whether a fiscal boost can be successful in shifting long-term structural trends in the economy is another matter. Politicians and investors have been more optimistic than economists on that question.

Europe is notably strong with all countries experiencing positive GDP growth rates through most of 2017 and most at an accelerating pace. All indicators are trending higher to paint a picture of a firming economy. With inflation remaining subdued, the ECB is expected to maintain its accommodative policies for several years.

Nevertheless, there are some landmines as evidenced by the 2017 elections in Europe. Even as the potentially disruptive elections (Netherlands, France, Germany) resulted in market-friendly outcomes, and thus lowered risk premia, the UK, German, and Austrian coalition-building within governments reveals fragility and discontent with current policies. This undercurrent of dissent will not soon disappear and is likely to influence markets in 2018 and beyond.

The UK economy continues to reflect home-grown weakness due to both the uncertainty surrounding the Brexit process and the re-valuing of the pound. Going forward, key factors in the economic outlook include whether real investment can continue to hold up and whether declining consumption trends can be reversed given the support of tight labour markets and strong household balance sheets. In our opinion, there is the very real possibility Prime Minister May's government does not survive past mid-2018 which would further pressure consumer sentiment, business intentions, and business investment due to regulatory uncertainty.

In Japan, Shinzo Abe’s decisive election victory and the ongoing rally in the Japanese market suggest the Japanese economy is likely to remain on a cyclical upswing. By the third quarter of 2017 the economy had delivered seven positive quarters of growth in a row, while business confidence, the stock market and unemployment all paint a positive picture. In addition, it is likely that Haruhiko Kuroda is reappointed Bank of Japan Governor in April 2018 ensuring the continuation of accommodative monetary policy unless there is clear evidence of inflationary pressures. With the leading economic indicator index at a multi-year high, we expect Japan to continue to grow beyond trend.

Emerging markets

Emerging markets (EMs) had a banner year in 2017 and are expected to remain strong into 2018, growing at a quicker pace than developed markets. The synchronised global upswing has boosted the world economy and has created a supportive environment with increased local and developed market demand, accelerating global trade, and gradually increasing commodity prices. Continued accommodative monetary policy and a dovish tightening cycle in developed economies have also supported local markets.

We see risks to EM growth coming from policy uncertainty in Turkey, Brazil, and from Mexico due to recent NAFTA doubts. China’s rapidly growing debt burden has yet to be unwound adding additional concern to the outlook as the impact of the economic transition away from exports and investment remains unclear. Further, EM growth rates and asset prices tend to be highly sensitive to monetary tightening cycles in developed economies. To the extent that policy normalisation in the US is faster than expected, with a concurrent strengthening of the US dollar, EM markets could come under pressure.

Dovish tightening cycle

Central banks have responded to quickening economic activity by signaling the coming of policy normalisation. In the US, the Federal Reserve announced the unwinding of its US$4.5 trillion balance sheet in the third quarter of 2017 and said it intends to continue with gradual rate increases. The ECB has indicated it would scale down its bond buying programme even as it extends it deep into 2018, if not longer. In Japan, monetary policy will remain highly accommodative as its economy recovers, with the Bank of Japan adding to its securities and the 10-year JGB yields remaining pegged at zero.

This activity points to a couple of conclusions: central bank balance sheets may not begin to shrink until 2020 at the earliest and the pace of the reduction will be significantly slower than the pace at which balance sheets expanded. Therefore, quantitative easing will not be fully reversed in the near- or the medium-term and central banks will continue to be accommodative. In short, our view is that, taken on its own, the ending of quantitative easing, is unlikely to de-rail the global economic recovery.